An Alternative Approach To Venture

Public Markets Practices In Private Markets

VC Fund managers continuously innovate to differentiate themselves in competing for capital (LP money), or deal access (startups). This innovation has introduced a variety of new ways to venture. In this post we shed some light on one of the new ways.

In private markets, VCs are basically buying shares early on, but the money doesn’t go to the seller, it goes to fund companies’ operations.

In a new approach, new VC firms are applying public market practices to investing in private companies. They directly buy shares from employees in special liquidity events, mainly in special tender offers.

This practice existed before in secondary markets where early investors usually exit by selling their shares to new ones. But it seems that VCs are now tapping into those who need liquidity the most, employees.

Early investors might not want to sell especially if the company is doing well. But an employee who has been working at a company for a few years after accepting a lower-than-market salary in return for stock options, might want to cash out some of her paper returns before an IPO or an acquisition.

For such employees, exercising their vested shares is costly, and it has to be done within a limited time window if the employee leaves the company. On the other hand, selling exercised shares is not an easy process, and it’s usually prevented by companies to keep control of who owns what and how much on the company’s cap table.

To solve the exercising problem, companies like “Secfi” finances options exercises for startup employees.

To solve for the selling problem, companies like Forge and EquityZen provide a marketplace where shareholders can sell their shares.

Although these marketplaces are considered a great solution for preferred shareholders (early investors), it is not easy (and in some cases impossible) for a common shareholder (employees). In almost all companies there are limitations on selling and transferring common shares for economic and regulatory reasons. Not to mention that institutional buyers might only be interested in buying preferred shares.

Here comes the new model. VC firms like 137 Ventures provide customized liquidity solutions to founders and early employees. In other words, VC firms approach companies directly (not employees) to suggest a tender offer and buy all sold shares, and in some cases negotiate preferred terms.

In this case, companies initiate tender offers to allow their employees to sell part of their vested shares in a controlled liquidity event. Companies have control over who can sell, who can buy, how much to exchange, and at what price. On the other hand, VCs get considerable equity in high growth startups.

Although this is not considered a funding round, because none of the invested capital will go to fund the company’s operations, it is still an opportunity for new VC firms to get access to great startups before an IPO or an acquisition and make some good returns.

I hope that more VC firms and startups adopt this approach to enable early employees to cash out part of their returns on yearly basis. This could be a great incentive to join such startups, and a great opportunity for startups to attract top talents early on when they can’t afford market-level salaries.